An Overview of Tax Administration Frameworks

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Tax Administration

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The centralized model allows for one tax administration to manage all taxes under one organization structure. This option reduces administrative complications and provides the benefits of a single management information system. It also ensures that the rules and regulations established at the central level are implemented uniformly by all subnational tax offices. This is a crucial aspect of efficient enforcement, especially the audit component, which can be simplified when tax inspectors have access to all taxpayer information at the same time. This is the case in the United States, where federal and state information can be shared through formal exchange agreements.

The choice between centralized or decentralized administration depends on political realities and the size of a country, rather than technical considerations. However, there are some important differences in the way that different countries manage their tax administrations, including the type of revenue sharing or tax assignment used.

Whether or not the central government is the sole tax administrator may also affect how effective tax policies are implemented. For example, if all taxes are collected by the central government, policy makers can be confident that tax measures designed to promote stabilization of the economy will be fully implemented. By contrast, if multiple levels of government are involved in collecting tax revenues, this confidence is not guaranteed.

While the centralized model can create problems in some cases, it is also possible for subnational tax administrators to control the taxes they collect. Typically, this is done through revenue sharing or tax assignment arrangements. These can take many forms, but the key issue is to allow lower levels of government to exercise legislative control over base and rate structures.

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Tax administration can be decentralized in a variety of ways. A central government can maintain control over all taxes and their collection or provide tax collection authority to one level of government other than the national government. It is also possible for a single level of government to collect all taxes and allow lower levels of government to legislate their own bases and rates. The latter option creates a more complex tax system because taxpayers must comply with more than one set of rules. This increases compliance costs and can lead to confusion and inefficiency.

One of the challenges facing countries with decentralized tax administration is that a number of key tax policies have significant repercussions on the ability of subnational governments to collect revenues and make responsible expenditure decisions. For example, if a central government imposes a flat-rate tax on all income sources but does not allow lower levels of government to influence marginal tax rates, local officials may feel that they are being penalized for their poor spending choices. Such situations can lead to discontent among local officials and distrust of the central government.

Another challenge is that the knowledge and skills needed to administer a property or sales tax are quite different from those needed to administer a personal income or payroll tax. It is therefore difficult to transfer the administration of these tax tools to the local level. The solution is to design a tax regime with the knowledge and skill sets required at the local level in mind, or to find other revenue tools that can be devolved to the local level.

The search continues for appropriately designed and easily administered revenue tools to match the growing trend toward devolution of expenditure responsibilities to lower levels of government. A common solution is to piggyback on a national tax base, such as the VAT or personal income taxes, and allocate revenues on a formula basis to subnational governments.

While this approach can simplify tax administration, it creates problems in the case of mobile tax bases such as imports and exports. In these cases, it is important for lower levels of government to be able to influence marginal tax rates in order to meet their expenditure needs.

Tax Assignment

Taxes are generally collected by either central or subnational governments. The choice of which level to collect taxes may depend on political or economic considerations. For example, some formerly socialist countries have assigned personal income taxes to local governments. Such an assignment, however, may not be feasible without adequate administrative capabilities at the lower levels of government.

Economies of scale are often important in making a tax a good candidate for subnational collection, and the simpler a tax is to administer, the more important those economies of scale tend to be. This is especially true for taxes that are based on a single tax base, such as property and excise taxes, as well as direct taxes such as sales and value added taxes (VAT).

Assigning some taxes to lower levels of government can also be problematic if the revenue sources don’t produce enough money to support the desired local services. This is a major concern for many local and intermediary levels of government in the OECD, where a large number of taxes are assigned to those levels of government. Such taxes include the following:

The administration of taxes assigned to the lower levels of government should also be based on reasonable methods for determining and settling apportionment disputes, including those involving taxpayers with multistate operations. The allocation of taxes among the states should be equitable for all taxpayers and should take into account all relevant factors. For example, the allocation of a taxpayer’s income should be based on the same method that the tax administrator used for the taxpayer in the prior year. In addition, the allocation of a taxpayer’s liability for a particular tax year should not be revoked unless there has been a material change in the facts upon which the previous determination was based or a substantial misrepresentation that would require an adjustment to the taxpayer’s tax liability. Moreover, the allocation of taxes should avoid the creation of large vertical fiscal imbalances.

Revenue Sharing

In a revenue-sharing arrangement, a government unit apportions part of its tax income to other units of the government. This process may involve different levels of governments in the same country, or between the central government and localities. Usually, laws determine the formulas by which revenue is shared and the receiving units are free from most controls by the granting entity. The system of revenue sharing has many advantages, but there are some challenges. One of the main challenges is that it can lead to perverse incentives, causing local governments to lower their official assessments. This can cause a downward spiral, as lower assessment leads to less revenue. Another challenge is that it can lead to a lack of consistency in tax collections across jurisdictions.

It is possible to achieve the benefits of revenue sharing without sacrificing efficiency and equity. However, to do so requires a good plan of action, a strong commitment from the parties involved, and adequate resources. It is also important to have a transparent process for sharing revenues. The parties involved should agree on a reporting method and schedule, and the responsible party should be in charge of collecting data and verifying it.

Moreover, it is important for all parties to keep track of their respective contributions and expenses. This helps them understand their overall financial picture and ensures that they are not being taken advantage of. In addition, a revenue-sharing agreement should include specific details about the tax consequences of any income or expense.

Although the choice of administration model can have substantial consequences for efficiency and equity, there are some functions that are essentially independent of the administrative decision-making model. This includes taxpayer services, collection, audits, penalties, and appeals. The choice of revenue-sharing procedures can, however, influence the behavior of staff in these areas. If staff perceive that a particular revenue-sharing formula is unfair, they might concentrate their efforts on collecting taxes retained by the central government rather than those that are shared with subnational governments.

A few countries use a hybrid model of revenue sharing, combining the advantages of the two models mentioned above. For example, India shares taxes between the central and state governments through a system of negotiated formulas. However, this system still allows states to collect their own taxes and is thus not entirely decentralized.